March 30, 2011

Back when position limits were first being debated at the CFTC in the summer of 2008, here on SWP I questioned whether the Commission had the statutory authority to impose limits in the absence of a finding that “excessive speculation” had caused unwarranted fluctuations in commodity prices. According to John Kemp of Reuters and Commodities Today, that argument has been raised by numerous commentors on the CFTC position limit NOPR:

The last day of the two-month consultation on Monday witnessed a volley of carefully coordinated submissions from Goldman Sachs, Barclays Capital, Morgan Stanley, the International Swaps and Derivatives Association (ISDA) and a host of others, all urging the CFTC to withdraw the proposed rulemaking.

Many of the objections build upon the criticisms set out at length by the Futures Industry Association (FIA) at the end of last week. The responses help lay the legal paper trail that will be cited when the rule is eventually challenged in the courts.

The gulf between the commission and the industry is so broad it is unbridgeable. A legal challenge to the CFTC’s authority to impose position limits appears inevitable. The only question now is who will bring it. None of the big banks, oil companies or institutional investors is likely to want to court controversy by acting as plaintiff.

But the rule could be challenged by an industry association on behalf of its members (there is safety in numbers) or by any individual firm willing to stand up and accuse the CFTC of over-reaching.

. . . .

But more fundamentally, most objectors argue the CFTC has no rationale and no legal authority to impose position limits at all, notwithstanding passage of the Dodd Frank Act in July 2010 (PL 111-203).

The FIA continues to argue the commission has no authority to impose limits unless it can come up with objective evidence that speculation has actually burdened interstate commerce and position limits are necessary to cure the problem.

BTW, I wasn’t coordinating with anybody. I think I was the first, and certainly among the first, to raise this issue.

I’m not a lawyer, and especially not an expert on statutory interpretation. Regardless of whether the law requires the CFTC to act only after making a credible finding that speculation has in fact distorted markets, however, I believe that would be the prudent course. Given the real potential for harm inherent in the regulation, it should be adopted only if that harm is balanced by some benefit. Insofar as harm is concerned, if the regulations are binding, that means definitively that they impose costs on market users. So what is the benefit? Is it too much to ask the Commission to demonstrate that they are intervening to fix a real problem?

As I noted in my comment to the Commission, it gave a very limited justification for its limits. What’s more, the limits as proposed were far more expansive than required to fix the problem that the Commission identified. Thus, in my opinion, the proposed limits are unduly burdensome. There are far more efficient ways to mitigate the specific problem that the Commission has identified.

On a related note, Kemp omits any discussion of another mandate in Dodd-Frank, namely, that the Commission determine the costs and benefits of its proposed regulations. Gensler has attempted to stonewall implementation of this black-and-white statutory language. Although he hides behind statutory language when he does not want to defend substantively his actions (“Don’t look at me! Congress made me do it!”) he blithely ignores that which he finds inconvenient. (Yet another soul looking for free options–politicians and regulators are particularly prone to this sort of opportunism.)

This suggests another legal and substantive attack on any position limit rule: even if a finding of “excessive speculation” is not required, the Commission should provide a cost-benefit justification for position limits. It has not done so.

With good reason. For if it even tries, the results will be laughable. The argument I raised in my comment letter would imply that the NOPR would not pass the cost-benefit test, and that it wouldn’t even be close.

But Gensler seems intent on pushing forward. If he succeeds (which is not assured, as indicated by the Commission’s cancellation of today’s meeting) the (bad) joke will be on the markets–and the millions who depend on them.

So, I presume the industry will see Gensler and the agency in court. I hope the plaintiffs (whoever they are) make both the statutory authority and cost-benefit analysis arguments. That would be very interesting.